Remember The HMO Revolution

Obama and the Democrats will soon propose big changes to US Medicine.  The two key issues are expanding insurance to the now uninsured, and controlling rising medical costs.

On coverage expansion, the debate now is mainly on how much a “public plan” available to all would displace private insurance.  If it displaced most private insurance via better access to government subsidies or preferred treatment, that seems just a backdoor way to get a “single payer” fully government system.   We’ll have to see what advantages the public plan is to get.

On cost control, there seems to be some faint hope of cutting medicine’s current tax exemption.   Arnold Kling suggested making the public plan a high-deductible catastrophic plan, and I suggested making medicine municipal.  But Obama’s main hope is apparently none of these; it instead seems to be to have a Medicare advisory commission suggest cuts, and

Require Congress to give an up or down vote on [its] proposals similar to how the defense base-closing commissions have worked in the past.  This kind of solution could help to insulate highly technical MedPAC recommendations from undue political influence.


When it comes to cost, they actually are starting with Medicare. They hope that the efficiencies work and are voluntarily adopted by private insurance.

To see what this plan is up against, wonks need to recall the failed HMO revolution of the 1990s.  The U.S. government and major U.S. businesses tried to push employees into HMOs, who held down costs by sometimes saying no to doctor-recommended treatment.   This worked spectacularly well for a few years, and then failed just as spectacularly as furious patients abandoned HMOs en mass, and forced the rest to stop saying no.  Costs then shot up to catch up with prior trends:


% US GDP to Medicine

Whatever Obama does to limit medical cost growth, I won’t call it a success until it works for longer than did the HMO revlution.  Does anyone know the politics of the end of the HMO revolution – was any US political faction pushing for that end?  And how was cost growth held down in the mid ’80 or ’00s?

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  • CannibalSmith

    Why are medicine costs growing exponentially exponentially in the first place?

  • This extensive study from “Economic Inquiry” finds no reduction in health care expenditures via HMO’s. Interestingly, in so doing, the authors mention Hanson’s favorite study of the American medical system, the RAND experiment, stating: “some studies (Ligon 1993, 1994; Manning et al. 1987) use experimental data of the RAN D Health Insurance Experiment. However, the obsolescence of this experiment and the continuously changing health care system render the findings in these studies irrelevant.”

    In my town of 100,000, an HMO organized in the 1980’s by a national firm was growing rapidly and dominating the medical marketing scene. In about its third year, a member required a heart-lung transplant, a service that was not available locally. His care bankrupted the local HMO, leaving all the other members to search for new insurance.

    As Hanson has pointed out repeatedly, the tragedy of America’s high health care costs is compounded by the poor outcomes the system produces. Whatever system evolves, reduction of costs will be a Pyrrhic victory unless it produces improved outcomes.

  • This graph is very interesting. Do you have breakdown by major components, like insurer profits, administrative overhead, doctors’ salaries, drug costs etc.?

  • retired, the data in that study is from 2000, well after the HMOs completely caved and had stopped trying to control costs.

    Cannibal, docs keep inventing new treatments and recommending them to patients.

    Tomasz, try here or here.

  • Michael Sullivan

    This graph plots medical expenses vs. GDP.

    On the one hand, one would expect the two to have a relationship in the long run, but it’s not clear that the two move in tandem in the short run.

    The obvious explanation for mid 80s and mid 00s slow growth rates relative to the years around them is that the economy was growing faster.

    In fact, it looks to me very much as though the times when medical spending grew rapidly as a % of GDP were the very times when real GDP was declining or growing very slowly, while the times when medical spending is flat relative to GDP were times when GDP grew rapidly.

    My hypothesis is that Health spending in real dollar terms over the last 30-40 years has tended to grow at very close to the same rate, no matter how the economy as a whole is doing, and that rate turns out to be roughly the rate at which the economy has grown in good times.

    So essentially medical spending is decoupled from affordability.

    This seems like an obvious consequence of the system we’ve had in place where most medical decisions do not get made by the people paying the bills. That system was put in place in the 40s and in full force by the mid 50s, and lo, that is exactly when spending began rising dramatically as a % of GDP.

    (when the government let employers treat healthcare as an expense that employees did not need to declare as a benefit.

    • TomB

      I think that Michael’s explanation sounds accurate and likely significant contributes to the pattern seen.

      Growth in medical spending may vary slightly as well. If we assume that there is a 5-10 year lag on returns from research and development (I made this figure up), and that when GDP grows so does a company’s ability to invest in research and development, then new treatments (which tend to be more expensive, especially at first) will hit the market when GDP growth is slow. Even though companies may be getting new revenue streams from the new products, on a company-by-company basis these are likely to be small at first and smaller than the investments in R&D at any rate.

      I would imagine that there is data out there that could corroborate or disprove this.

    • Ari

      In fact, it looks to me very much as though the times when medical spending grew rapidly as a % of GDP were the very times when real GDP was declining or growing very slowly, while the times when medical spending is flat relative to GDP were times when GDP grew rapidly.

      This seems like an interesting model for constantly “racheting up” the %GDP spent on health care. When GDP is rising, health care costs are proportionally constant (i.e., rising in absolute $). When GDP is falling, health care costs are constant in absolute $ (i.e., rising in terms of %GDP). In other words, the growth rate in absolute $ is the maximum of GDP growth and 0 — but it doesn’t “feel” like we’re spending more, because there are always units in which the expenditure appears constant.

  • diogenes

    Reforming MedPac is an important piece of an health care reform. Although its a technical body, its rather well known how easily its susceptible to political manipulation. Its judgments are also basically used by the majority of private insurers as well.

  • Jeff

    Access to taxpayer funds isn’t the only difference between a government-run public option and a nonprofit one. Another key difference is political power. Thus a public option, even if it has no access to taxpayer funds, may still be able to dictate terms in ways that private insurance companies have been only mediocre at.

    In addition, other than your and Greg Mankiw’s conservative principles, the argument against use of taxpayer resources for the public option is pretty weak. The goal is not to promote competition. And though the goal should be to produce better health, it’s been framed to everyone as providing health care. If a taxpayer-resource-using public health care system outcompetes private insurance, that right there is argument that the taxpayers want government health insurance.

  • John Thacker

    Does anyone know the politics of the end of the HMO revolution – was any US political faction pushing for that end?

    Roughly speaking, Democrats pushed for the end of the HMO revolution. Not phrased exactly as such, but they pushed for new laws forcing health insurance plans to cover various items, require hospital stays after births, etc. Unsurprisingly, the AMA, fresh off opposing HilaryCare, supported such proposals, so there was a fair amount of bipartisan effort.

    It’s sort of a reversal now; Democrats apparently will now be defending the government making exactly the sorts of decisions that they attacked private insurance doing.

    • This is interesting; someone who knows this history should write up this comparison.

  • Looking at that chart, I would say recessions cause increasing healthcare costs and growth tempers them. Fits with reduced numbers of insured carrying heavier costs. HMOs may have done a better job of this, but seem unlikely to ever permanently change anything.

  • CannibalSmith asked:

    Why are medicine costs growing exponentially exponentially in the first place?

    The original blog post showed a graph of health care costs as a percentage of GDP over time. Is there any causal relationship between the two? I doubt it, but If there is, which way does it go?

    More likely, still, there are other, more important, factors that influence health care costs. Let’s examine the effects of the aging demographic profile. Let’s look at medical malpractice settlements and the effect on insurance premiums. Let’s look at the lack of preventive medical practices (that would reduce more costly procedures in the future). Let’s look at the growth in (what I call “frivolous”) drugs for every minor ailment known to mankind, the expensive ads that promote their use, and the cost of prescribing “labor”. Undoubtedly, there are many more.

    Make no mistake, it is not GDP that causes health care costs to rise. Given the size of the health care “industry”, it is possible that it has a significant impact on GDP growth, however.

  • George

    In an interesting twist, it was Democrats such as Ted Kennedy who were promoting HMOs back in the 1970s.

    And as always, I think three things should be noted:

    (1) those expenses are for medical care, not health;

    (2) medical care is not the same product year-to-year, and it’s effectively illegal to offer the 1980 version of medical care today, in spite of the fact that it would be vastly cheaper;

    (3) the service the medical community offers is Not Dying; demand for this is pretty close to completely inelastic (i.e. Would you rather give up all your worldly possessions, or die?)

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